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A month ago I came across this study made by Saras D. Sarasvathy of the University of Virginia which addresses the question: What makes an entrepreneur, entrepreneurial? We all know what entrepreneurs are and we know what they do but the question of where do this actions come from and how do they come up with such ‘plans’ are as elusive as their source of ideas. And what if this way of thinking can be duplicated, taught, and learned? This questions got me excited as i read, so here is the study as i understand it:

There are two types of reasoning:
1. Causal Reasoning - achieve a goal using given means finding the optimal alternatives
2. Effectual Reasoning - goals emerge from the given means

Causal Reasoning revolves around the logical way of thinking. In business schools, it would have the following process:
1. Market Definition
2. Segmentation (using relevant variables such as age and status)
3. Targeting (an example would be expected returns)
4. Positioning (use of marketing strategies)
5. to reach a CUSTOMER

Now this way of thinking has been used for years and years because of its ability to predict the future using the data that came in with the research (feasibility study as I would understand it), however this entails costs, time, effort and not to mention its probability to still fail after launching the product. To solve the problem (very unconventionally), entrepreneurs do the process the other way around.

Effectual Reasoning:
1. CUSTOMER identification (through Effectual Reasoning Means)
2. Customer definition (strategic marketing and selling)
3. Adding Segments and Strategic Partners
4. Definition of one of several markets

Effectual Reasoning Means:
1. Who they are
2. What they know
3. Whom they know

Using the means above, an entrepreneur would maximize his resources rather than come up with the resources. A customer then is defined by the value you could give them rather than creating the value that they need. Now instead of launching the product big time (advertisements, promotions, etc.) with how much budget they have, entrepreneurs tend to sell it directly to the nearest customer reachable or to friends and relatives who might be interested. From there, an entrepreneur would exploit other customers based on the sales made initially. What are the qualities of the people who bought the product, where do they live, what do they do? These are some of the questions that might help reach other customers. Then an entrepreneur, based on the defined customers would find strategic partners, people who have the same interests in furthering the cause and a relationship is made (this is something that is not taught in business schools). Several markets will emerge in the process creating a vast array of opportunities available for entrepreneurs to exploit. Of course, the most profitable will be chosen and refined further.

To sum up the process, here are the major differences:
1. Causal reasoning concentrates on expected returns while Effectual reasoning emphasizes on affordable loss (instead of targeting a market, an entrepreneur would bring the product to the nearest possible customer with zero resources)
2. Causal reasoning depends on competitive analysis while Effectual reasoning builds on strategic partnerships (the challenge is to pick a partner whom you could leverage early on before even taking capital out)
3. Causal reasoning exploits pre-existing knowledge and prediction while Effectual reasoning stresses leveraging on contingencies (the ability to turn the unexpected into profitable)

Focusing on the last point, entrepreneurs uses the ready-fire-aim approach model. They don’t think too much of the outcome but test the product as it is and adjust as they go along developing it. This approach will actually do more in the long run. Added to that, entrepreneurs don’t like the idea of predictable future, they like to ‘create’ the future. Not all surprises are bad and it is not the contingencies but the leveraging that entrepreneurs do.

Here are the principles behind each reasoning:
Causal reasoning - to the extent that we can predict the future, we can control it
Effectual reasoning - to the extent that we can control the future, we do not need to predict it

To illustrate the principles above, let’s say that an urn has a given of 10 red balls at 100 points each and 10 green balls at 0 points each, causal reasoning would risk 50 points for every draw since the chances of getting a red ball is 50/50. However, with the premise that life has no given colors and number of balls to be drawn upon, the only way to predict the future is carefully noting what you draw each time creating the ratio as you go along. In essence, one of the interviewed entrepreneur explained:

Whatever the initial distribution of balls in the urn, I will continue to acquire red balls and put them in the urn. I will look for other people who own red balls and induce them to become partners and add to the red balls in the urn. As time goes by, there will be so many red balls in the urn that every draw will obtain one. On the other hand, if I and my acquaintances have only green balls, we will put them in the urn and when there are enough, we’ll create a new game where green balls win.

Entrepreneurs don’t like the idea of predictable future, since there would always be the smarter and the richer who could use this predictability to their advantage, whereas contigencies help entrepreneurs shape the future.

This idea doesn’t mean Effectual Reasoning is more effective. In fact, the more knowledgable an entrepreneur is on both reasoning, better results come out. But when do you know when to use which? As I read through the study, the pattern would somehow be like this. Effectual Reasoning is better used in the early stages of development until a business is established, however, Causal Reasoning will have to support the business as it grows bigger. So knowing both acts as a leverage for entrepreneurs. In addition, Effectual reasoning may not necessarily increase the probability of success of new enterprises, but it reduces the cost of failure by enabling the failure to occur earlier and at lower levels of investments.

And finally, what makes an entrepreneur entrepreneurial? And i’m quoting Sarasvathy on this:

Entrepreneurs are entrepreneurial, as differentiated from managerial or strategic, because they think effectually; they believe in a yet-to-be-made future that can substantially be shaped by human action; and they realize that to the extent that this human action can control the future, they need not expend energies trying to predict it. In fact, to the extent that the future is shaped by human action, it is not much use trying to predict it - it is much more useful to understand and work with the people who are engaged in the decisions and actions that bring it into existence.